Investors Are Betting Big Against Whiting Petroleum Corp -- Why They're Wrong

Image source: Getty Images.

Despite sinking more than 40% this year, some investors believe that there's still plenty of downside at Whiting Petroleum (NYSE: WLL). That is evidenced by the fact that 25.6% of the Bakken-focused driller's stock was sold short, according to the most recent data. In fact, traders have recently been increasing their bet against the company, with short interest rising 3.2% over the past couple of weeks. However, this gamble could backfire badly even if oil prices do not rise because of the steps Whiting has taken this year to improve its financial situation and operations as well as a key basin-specific catalyst that's on the horizon.

Heading in the right direction

There's no doubt that Whiting Petroleum entered 2016 in rough shape. Due to persistently weak oil prices and a concerning financial situation, the company initially set a $500 million capex budget for 2016, which represented an 80% decrease from 2015. Most of that capital would be spent in the first half to complete wells drilled in 2015, with the company initially only intending to invest $80 million in the second half as it had expected to wind down its well completion operations. As a result of the decrease in spending, Whiting forecast a significant production decline for 2016.

Since then, the company has taken several steps to get back on track. On the balance sheet side, it entered into a series of debt exchanges, which cut debt by 34%, bringing it down to $3.7 billion. In addition to that, it sold several non-core assets, including properties in Texas for $300 million and the recently announced sale of some of its Bakken midstream assets to Tesoro Logistics (NYSE: TLLP). That deal is expected to close early next year and will result in Tesoro Logistics sending Whiting $375 million in cash, which will further strengthen its balance sheet and enhance its financial flexibility.

Whiting has also made significant progress to improve its costs and capital efficiency. For example, lease operating costs were below the low end of its guidance range last quarter while production was at the high end of guidance. One of the drivers of production is the company's recent well results in the Bakken, which have been exceptional thanks to its decision to use more sand per well. These factors have the company on pace to achieve better results in 2016 than it initially expected.

Image source: Getty Images.

A catalyst on the horizon

With the upcoming cash payment from Tesoro Logistics, Whiting Petroleum will enter 2017 in a much stronger financial position. When combined with improving well results, Whiting has significantly lowered its breakeven point, which positions the company to run at much lower oil prices going forward.

In addition to all those self-help initiatives, there's an outside catalyst on the horizon that could push its breakeven point even lower. Pipeline giantEnergy Transfer Partners(NYSE: ETP) is trying to put the finishing touches on the Dakota Access Pipeline, which will move oil from the Bakken to Illinois, where it can then travel to refineries along the Gulf of Mexico.While the Energy Transfer Partners pipeline is currently facing extreme opposition from environmentalists and Native American groups, it is nearly complete and will likely go into service early next year, especially considering the outcome of the recent presidential election.As the leading Bakken producer, this pipeline isan important catalyst for Whiting because it will significantly reduce transportation costs, providing Whiting with more cash flow to investinnew wells next year. In fact, according to Whiting CEO Jim Volker, the Energy Transfer Partners pipeline could shave as much as $3 per barrel from its transportation costs in the Bakken, which could lower the company's overall breakeven point to $47 per barrel.

Investor takeaway

Unless oil pricestake another tumble, there doesn't appear to be much downside left in Whiting's stock. Instead, given its improving balance sheet, capital efficiency gains, and the upcoming Dakota Access Pipeline from Energy Transfer Partners, there's ample upside even if oil stays in its current range. Meanwhile, if crude rebounds sharply, it could fuel quite a rally in Whiting's stock, which could scorch short-sellers.

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